Question
Principles of Managerial Finance 14th ed. Lawrence Gitman and Chad Zutter P7-17 (pg. 306) Using the free cash flow valuation model to price an IPO
Principles of Managerial Finance 14th ed. Lawrence Gitman and Chad Zutter
P7-17 (pg. 306)
Using the free cash flow valuation model to price an IPO
Assume that you have an opportunity to buy the stock of CoolTech, Inc., an IPO being offered for $12.50 per share. Although you are very much interested in owning the company, you are concerned about whether it is fairly priced. To determine the value of the shares, you have decided to apply the free cash flow valuation model to the firms financial data that youve developed from a variety of data sources. The key values you have compiled are summarized in the following table (see table pg. 306).
Table
Year (t) | FCFt | Other Data |
---|---|---|
2016 | 700,000 | Growth rate of FCF 2019- infinity=2% |
2017 | 800,000 | Weighted average cost of capital=8% |
2018 | 950,000 | Market value of all debt=$2,700,000 |
2019 | 1,100,000 | Market value of preferred stock=$1,000,000 |
Number of shares of common stock outstanding=1,100,000 | ||
a.) Use the free cash flow valuation model to estimate CoolTechs common stock value per share.
b.) Judging on the basis of your finding in part a and the stocks offering price, should you buy the stock?
c.) On further analysis, you find that the growth rate in FCF beyond 2019 will be 3% rather than 2%. What effect would this finding have on your responses in parts a and b? Please show all work and formulas used.
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started